Brehm #5

Question 1

Steps in the evolution of a LOB (4)

Answer 1

1. emergence
2. control
3. breakdown
4. reorganization

Question 2

Description of the emergence phase of the LOB evolution cycle

Answer 2

as new LOB arises, data is thin, demand grows quickly, and pricing is erratic (price wars set in with new competition)

eventual solvency crisis forces price correction where weak competitors exit, followed by a period of profitability before the cycle “restarts”

Question 3

Description of the control phase of the LOB evolution cycle

Answer 3

stabilization obtained through collective coercive control where rating bureaus and DOIs regulate price changes and restrict entry

Question 4

Description of the breakdown phase of the LOB evolution cycle

Answer 4

control regime breaks down as technology and societal changes bring in new competitors (not under control) who take business away

Question 5

Description of the reorganization phase of the LOB evolution cycle

Answer 5

a new version of the LOB emerges and returns to emergence phase conditions

Question 6

Phases of LOB evolution driven by competition (3) vs. statistical data lags (2)

Answer 6

competition - emergence, breakdown, and reorganization

data lags - control and breakdown

Question 7

Underlying themes of the UW cycle (3)

Answer 7

1. time lags b/w compilation of historical data and implementation of new rates&raquo_space; poor extrapolation of rate need
2. competition and relatively poor quality of forecasting abilities from inexperienced firms pushes the market towards lower prices
3. impact of capital flows on supply and demand

Question 8

Dependent (2) and independent (5) variable examples in an UW cycle model

Answer 8

dependent: LR or CR

independent:
1. historical values of dependent variable/components
2. financial variables
3. regulatory/rating variables
4. econometric variables (ex: inflation, unemployment, GNP)
5. financial market variables (ex: interest rates, stock market returns)

Question 9

Dimensions (3) of modeling styles and ranking of approaches

Answer 9

1. data quantity, variety, and complexity: soft > behavioral > technical
2. recognition of human factors: soft > behavioral > technical
3. mathematical formalism and rigor: technical > behavioral > soft

Question 10

Types of approaches to modeling the UW cycle (3)

Answer 10

1. soft
2. behavioral/econometric
3. technical

Question 11

Examples of soft approaches to modeling the UW cycle (3)

Answer 11

1. scenarios
2. Delphi method
3. competitor analysis

Question 12

Examples of technical approaches to modeling the UW cycle (2)

Answer 12

1. autoregressive time series analysis

2. general factor model

Question 13

Key components of behavioral/econometric approaches to modeling the UW cycle (2)

Answer 13

1. supply and demand curves

2. available capital

Question 14

Supply curve and impact of post-shock and competitive limits

Answer 14

in order to bring more quantity (supply) to market, must increase price (so moves up and right)

post-shock: under restricted capital, must increase price to maintain quantity

competitive limit: under pressure of new entrants and technological advancements, must reduce price to maintain quantity

Question 15

Demand curve and impact of post-shock and capital-rich environments

Answer 15

in order to sell more, firms must reduce price (so moves down and right)

post-shock: under restricted capital (lower quality capital), lower quantity demanded at the same price

capital-rich: with higher quality capital (= lower probability of default), more quantity demanded at the same price

Question 16

Gron supply curve and impact of restricted capital

Answer 16

firms sell at a set price up to a given capacity threshold, at which point, they need more capital (higher price) to support more business

> > w/ restricted capital, reach capacity threshold sooner

Question 17

Definition of the UW cycle

Answer 17

The recurring pattern of increases and decreases in insurance prices and profits